News Release

Chief Financial Officers See More Downside Risk in the Stock Market than Upside

February 20, 2013

Everybody is looking for a crystal ball into the economy. Duke University may not have exactly that, but the quarterly Duke/CFO Magazine Global Business Outlook Survey anticipates economic activity a quarter sooner than other surveys. Now, an analysis by Professors John Graham and Campbell Harvey of the results collected over the years shows Chief Financial Officers aren't feeling good about stock market returns.

CFO forecasted long term (10 year) returns of the Standard and Poor's 500 were the lowest in December 2012 since Duke began asking the question of CFOs in June 2000. The analysis also shows CFOs are more uncertain about the economy than in most other quarters. CFOs are also anticipating a decrease in the risk premium (expected 10-year S&P 500 return relative to a 10-year U.S. Treasury bond return.) Read the full paper.

This analysis has implications from retirement to fears of the stock market "overheating." Professor Campbell Harvey breaks down the findings in a Fuqua Q and A.

1. Do you consider these findings a reflection of the "new normal" in the market? Should we be resigned to low returns and low growth?

"Prospective returns are very modest. First, consider the bond market. A long-term bond yields approximately two percent, which is the rate of inflation. Hence, there is no "real" return. Turning to the equity market, many would consider the market "fully valued." Hence, prospective returns are also modest. This is confirmed by the CFO forecasts. One consequence of low returns in the bond and stock markets is that investors are chasing riskier investments, such as investments in emerging markets or small risky investments in the U.S."

2. What do you think these findings say about retirement plans?

"For most plans, it is hard to justify any exposure to long-term bonds given that you are locking no real return. While equity returns are lower than usual, they are still higher than prospective bond returns. Hence, you are seeing increased interest in equity allocation (but with very modest expectations.)"

3. A top Federal Reserve official made references earlier this month to possible "overheating" of some parts of the credit market. What do you think this analysis of CFO opinions says about the possibility of "overheating?"

"The overheating of the credit market is a direct result of the Fed's low interest rate policy. Why buy a Treasury bond with a zero percent real return? People are looking to other types of fixed income investment (such as corporate bonds.) These investments offer higher expected returns because they are riskier. Also, as more and more people buy these corporate bonds the prices go up and the credit spreads get very tight (the so-called overheating.) The Fed's policy has had arguably an unintended consequence of making investors' portfolios riskier."

4. Looking at this analysis, what kind of insights can you gain from CFOs about the types of investments people should be considering moving forward?

"This is a time of extraordinary risk that is mainly induced by policy makers. There are two main sources. First, there is the risk that the government cannot agree to fix the unsustainable course it is on with four consecutive trillion dollar fiscal deficits. Part of this risk has to do with the potentially debilitating measures (such as tax increases) that would choke the nascent recovery. Second, there is a risk that the Federal Reserve will not be able to reverse the extraordinary monetization it has pursued since the financial crisis. The Fed is essentially bankrolling the Federal government to the tune of $85 billion per month. It will not be easy to take this back. If they fail, inflation will inevitably increase. Inflation will sharply increase the cost of government financing and create a vicious circle where more money is needed to be printed."